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Why Conservatives Hate Fiscal Policy

Obstinate ignorance is usually a manifestation of underlying political motives.

— Michal Kalecki

BERNIE SANDERS IS PROPOSING AMERICA spend $15 trillion over the next 10 years, improving infrastructure, increasing Social Security, extending Medicare to all, and making public universities tuition-free. All these programs are tempting and desirable, but they feel extravagant. Can we afford them? Maybe that is the wrong question.

Ever since John Maynard Keynes wrote his General Theory 80 years ago, economists have known the best medicine to boost a stagnant economy is increased government spending. The last time the economy was in this bad of shape it took a World War to power us out of the Great Depression. This time around, Sanders’s proposed government deficit spending on infrastructure, education, and health might allow us to finally emerge from the Great Recession without sending our sons and daughters into battle.

The global economic slowdown that began in 2008 threatens to last even longer than the Great Depression. Although the recession officially ended almost seven years ago, the recovery since has been disappointing, to say the least. Wages stagnate, the middle class shrinks, and good jobs are still hard to find. Most postwar recessions saw a small drop in GDP followed by a rapid return to previous trend line growth. Not this time. The US economy is $3 trillion (almost 20 percent) smaller today than projected in 2007.

And with the Chinese economy slowing, the stock market tanking, world trade shrinking, oil prices plummeting, deflation threatening, bond yields falling, and emerging markets collapsing, a recession this year looks more likely than a strong self-sustaining economic expansion. We might well fall into another recession without ever enjoying the boom.

Our disappointing economy can no longer be blamed on the financial crisis. By 2009 (or 2010 at the very latest) the financial crisis was over, markets liquid, and banks recapitalized. Bailing out the banks was morally distasteful, but policymakers had little choice. In the fall of 2008, most major banks were insolvent, their debts larger than their assets.

We were a week or two away from blithely putting our cards into the ATM machine and finding our savings, which we assumed were sitting in a vault somewhere waiting for us, had evaporated. Giving banks billions protected depositors and saved the financial system but didn’t do much for the real economy. Were our problems merely due to the financial crisis, the economy should have recovered a long time ago.

Why does the economy remain so fragile? The mainstream position, popular amongst pundits, politicians, and the general public (albeit disdained by most economists), is that we are paying the price for our extravagance during the bubble years. We borrowed foolishly to live beyond our means so now we must suffer for our sins. Austerity, the sadomonetarists tell us, is the painful but necessary cure.

These Austerians insist government spending must fall, and taxes on ordinary citizens must rise. Greece is their poster child; the government deficit their obsession. They claim, without presenting evidence, that once government lives within its means, business confidence will magically reappear and the economy will happily stride forward.

Austerity sounds convincing to those of us who don’t know much economics because it does make intuitive sense. “When families are cutting back their spending, so should government” is a brilliant sound bite, even if it isn’t true. By personalizing and moralizing a more complicated story, this meme dominates popular discourse, although it has been disproved by 80 years of economic history and theory. Austerity hasn’t worked for Greece. It really hasn’t worked anywhere. Austerity is 180 degrees off. Its exact opposite, a stimulative fiscal policy, would be better medicine.

Governments have two tools with which to affect the economy: monetary and fiscal policy. Ever since the financial crisis, they have used one with exuberance and the other hardly at all. Interest rates have been cut to historic lows, central banks have been extravagantly buying debt — shoveling money into bankers’ coffers. Meanwhile, other than Obama’s half-hearted stimulus in 2009 and China’s splurge into infrastructure spending in response to the Great Recession, fiscal policy has been disdained. The most extreme monetary policy in history has not been able to cure the economy, and yet politicians still advocate austerity and fulminate against fiscal stimulus. With interest rates almost zero and monetary policy maxed out, were another recession to hit we would have no room to stimulate the economy with a rate cut.

Distinguished establishment figures, from Ben Bernanke to Larry Summers to Martin Wolf, agree that deficit fetishism has been destructive, that monetary policy is insufficient, and that stimulative fiscal policy must play a role in energizing our economy. The economics blogosphere is largely united, backing increased government spending. But all this intellectual firepower seems to have almost no effect on policy. Politicians in power and their minions in the media remain fixated on cutting the deficit.

World War II is proof that fiscal policy works. In 1938, US unemployment was almost 20 percent and the government deficit was not coincidentally a mere 0.1 percent of GDP. In 1943, the deficit rose to 26 percent of GDP, and unemployment fell to barely over one percent. US GDP doubled in less than four years. Remember that it wasn’t the slaughter of civilians or the destruction of cities that reinvigorated the economy, it was government deficit spending, creating demand sufficient to match our growing ability to supply. Building bridges or hiring teachers or providing universal healthcare would have been far better for the economy than killing Nazis. War, unfortunately, seems to be the only way conservatives are willing to countenance increased government spending.

Currently, government spending is between $3.5 and $4 trillion, the deficit is $0.5 trillion, and US GDP is around $17 trillion. Bernie Sanders’s proposals are estimated to cost $1.5 trillion a year. He plans to raise taxes on the wealthy, so let us imagine the deficit would increase $750 billion a year. This would be a fiscal stimulus of four percent of GDP, considerably less than what we spent defeating the Axis powers. That it would boost GDP and increase employment is undeniable. That it seems extreme is only evidence of the disdain “very serious people” now feel toward fiscal policy.

During the Golden Age, the postwar period from 1945 to 1973, fiscal policy was mainstream — the basic weapon in economic policymakers’ tool kit. Back then, they recognized full employment was their primary responsibility, and so recessions were short and shallow. Firms knew increased government spending was guaranteed in case of a slowdown and that gave them confidence to invest. Fiscal policy worked brilliantly during the Golden Age. In the US, real median wages more than doubled in less than 20 years (in the 40 years since, they have barely gone up at all). World GDP grew faster than ever before or since.

Everything changed in the 1970s. The 1973 recession was the deepest in a generation, OPEC made energy expensive, and stagflation suggested the trade-off between unemployment and inflation was not as inevitable as the Phillips curve made it out to be. Conservative economists, imbued with rational expectations theology, “proved” that fiscal policy provided only temporary succor and ultimately would goose inflation. After Volcker and Thatcher eliminated seemingly intractable inflation by raising rates in 1979 (and then restimulating the economy by cutting them in 1982) monetary policy became the economic tool of choice.

During the Great Moderation, economists and policymakers believed monetary policy was so powerful that fiscal was unnecessary. Any time markets sputtered, rates were cut, and they took off again. This is not to say that fiscal policy was not used. The Reagan boom was essentially military Keynesianism (the deficit almost quadrupling between 1979 and 1984), but despite what all of us learned in Econ 101, spending your way out of a recession became anathema amongst the policy elite.

And so the Bundesbank and the European Central Bank insist southern Europe tax more and spend less. And so Republicans in the US Congress shut down needed infrastructure projects. And so “very serious people” insist that balancing the budget will in some metaphysical way stimulate the economy. It is worth remembering that conservatives are happy to be Keynesians when tax cuts are proposed. When George W. Bush wanted to lower taxes on the richest Americans, he explained that they would spend their windfall, and their wealth would trickle down to the rest of us. The deficit didn’t bother Republicans then.

Why does austerity remain popular? Because ordinary citizens think it makes sense. And why wouldn’t they? It is a simple story, easily digested, that reflects personal experience. But it is hard to believe that the politicians running the show have never heard of John Maynard Keynes, fiscal policy, or the fallacy of composition. Perhaps it is self-interest, rather than ignorance, that makes the rich and powerful oppose stimulative deficit spending.

In his famous 1943 essay “Political Aspects of Full Employment,” Polish economist Michal Kalecki noted that during the Great Depression, big business railed against fiscal policy even though they recognized they would benefit from increased demand. Economists knew government spending could produce full employment. Entrepreneurs knew creating jobs would spark sales and increase profits, but nonetheless big business opposed stimulative fiscal policy.

“Discipline in the factories” and “political stability” are more appreciated than profits by business leaders. Their class instinct tells them that lasting full employment is unsound, and that unemployment is an integral part of the “normal” capitalist system.

Entrepreneurial profits might be higher under government sponsored full employment, but businesses’ power would be reduced. “Under a regime of permanent full employment, the ‘sack’ would cease to play its role as a disciplinary measure.” Kalecki notes that the appeal of fascism to big business in the 1930s was that by militarizing government spending, fascists created jobs, stimulated the economy, and increased profits without the noxious byproduct of empowering the working class.

The great fear of bondholders and the rentier class is inflation. Government spending, which could spark inflation, is their bête noire. It may be ignorance of economics that makes ordinary citizens favor deficit cutting, but I suspect that isn’t the motivation of the rich and powerful. The horror that bondholders feel at being repaid with depreciated currency has a remarkable, albeit largely unseen, political power.

Unemployment doesn’t matter much to the top .01 percent. Their wealth comes not from wages but from rising asset prices. No wonder they love monetary policy — especially unconventional monetary policy such as Quantitative Easing, which works directly by goosing asset prices. Almost all of the benefits of monetary policy since the financial crisis have gone into the pockets of the top one percent. The rich indeed got richer, but their wealth did not trickle down.

Cutting interest rates almost inevitably raises asset prices, and since stocks, bonds, businesses, and houses are generally owned by the affluent, that makes rich people richer. Monetary policy, like tax cuts, is trickle down economics. Make money cheaper, entrepreneurs are more likely to invest. Make money cheaper, all other assets rise in value. Make rich people richer by raising asset prices, hope they will spend it, and perhaps the rest of us can get jobs servicing their needs.

Fiscal policy is trickle up economics. By spending money building schools or roads or even bombing Dresden, government puts money into the pockets of working folks. Their spending increases demand, stimulates sales, profits, investment, and employment. Workers win, as do entrepreneurs, but the workers get their money first. The economy grows, and the rich get richer, just not as fast as the poor and middle class. Fiscal policy stimulates the economy by creating jobs and putting money in the pockets of ordinary workers; monetary policy works by putting money in the pockets of rich folks.

It is undeniable that an energetic fiscal policy would make the economy grow. Every undergraduate learns that in Econ 101. One could object that increased government spending might be inflationary, but in our current deflationary environment, that would be a plus. Today, interest rates are exceptionally low, making infrastructure investments remarkably cheap. The debacle with Flint’s water supply, that Minnesota bridge falling into the Mississippi river, the disaster that is Kennedy Airport tell us infrastructure improvements are required. Increased government spending would create jobs today and make our country physically stronger tomorrow. It would help workers by creating jobs, and help entrepreneurs by creating demand. Roads would be better; schools would be better. Corporate profits would most likely rise. The only losers would be the rentier class and the very rich.

The great mistake of Obama’s presidency was his shift in 2010 away from fiscal stimulus and toward deficit-cutting. Obama must have known better. His much-maligned stimulus snapped America out of recession, created 6 million jobs, and increased US GDP by more than two percent. His advisors certainly understood the economic benefits of fiscal policy. I’m convinced his pivot toward austerity in 2010 was politically motivated. He feared attacks by Republicans accusing him of being spendthrift and did not have confidence that he could explain the benefits of Keynesian economics to the American people.

Admittedly, the logic of Keynesianism is not as intuitive as that of austerity. Nonetheless, it can be explained reasonably clearly in a paragraph or two. The super rich, who still control much of the media, aren’t interested in showing how increased infrastructure or welfare spending would create jobs or stimulate growth. They are happy with our continued assumption that those beneficial programs are just too expensive and that deficit-cutting should be the primary goal of economic policy.

Bernie Sanders’s programs will certainly benefit America’s health, education, and infrastructure. You will be told we cannot afford them. This is a lie. When the private sector does not want to open its wallet, the public sector must pick up the slack. That is the fundamental lesson of Keynesian economics, proved by both theory and history. The only risk of deficit spending is that it might spark inflation, but if it does, an interest rate hike should be enough to staunch it.

There is nothing radical about Sanders’s plan. It is utterly mainstream economics, even if the super rich and their minions in the media don’t want us to know that. Eight years of extreme monetary policy has proved interest rate cuts can’t do the job by themselves. Instead of hoping negative interest rates or Quantitative Easing forever might someday spark self-sustaining growth, it is time for policymakers to embrace stimulative fiscal policy.

The .01 percent disdain fiscal policy for sensible self-interested reasons. The rest of us, not so much. We have been bamboozled by the super rich’s fear of inflation and hatred of government spending. Right now, the most important thing progressives can do is educate voters about the advantage of a stimulative fiscal policy. Otherwise, “obstinate ignorance” and a malign obsession with deficit cutting will continue to bedevil our economic prospects no matter who becomes president. If we don’t stimulate the economy by investing in the things we need, we might end up, like the last time, stimulating it with war.